CFA Research Challenge - KKD Analysis

CFA Institute Research Challenge Jan 24, 2013

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CFA Institute Research Challenge hosted by

CFA Society North Carolina C

Highlights

We issue a sell recommendation with a target price of USD 12.65. Krispy Kreme is trading at nearly 5 times its book value and issues no dividends. The company is climbing out of recov-ery mode and is highly scrutinized under the analysis spotlight which makes them more vola-tile towards market forces and news updates. KKD is one of the biggest signature brand doughnut providers recognized around the world. Since the stock price is above our intrinsic value we recommend to sell KKD until they solidify themselves as a strong growth stock.

Main price growth drivers: 1) Total revenues are estimated to grow by 9.31% in FY 2014. Company same store sales grew 8.4% through Q3 of FY 2014 while domestic franchise grew 11.2% and international stores fell by 6.4%. Revenues are a main determinant in area devel-opment and future growth potential. 2) Franchise agreements will drive KKD’s expansion domestic and internationally. The company’s goal is to have 1300 total stores by 2017. Suc-cess or failure of the company leans heavily on international franchisees who plan to own 900 stores worldwide by 2017, which represents 69% of total store count.

Retrenchment and recovery: In 2004, KKD experienced a financial crisis due to rapid expan-sion that oversaturated the market and a domestic franchising strategy that focused on short-term profits instead of long-term growth. From 2004–2009 over 240 stores closed, resulting in USD 300 million in impairment charges, loss of revenues and a plummeting share price. Since then, new management and strategic changes have to led to stronger fundamentals, improved investor confidence, and accelerated store growth.

Main risk issues: 1) Cannibalism resulting from overexpansion is one of the biggest risks moving forward. If the company allows the market for their signature doughnuts to become diluted, they could see loss of profits and store closings. It is important for KKD to not make the same mistakes again. 2) Macroeconomic issues greatly affect KKD now that they have a global brand. Consumer confidence, employment and the disposable income of consumers can influence sales as well as the overall health of sovereign economies in countries that KKD operates in. 3) Competition amongst fast food restaurants is fierce as they all attempt to offer their products for the best deal for consumers. KKD has to compete not only with fast food and bakeries, but also with wholesale markets and international markets where their brand name is not as strong.

Krispy Kreme Doughnuts Inc. [Quick Service Restaurant Industry, Consumer Discretionary Sector]

This report is published for educational purposes only by students competing in The CFA Institute Research Challenge.

University of North Carolina in Wilmington Student Research

Date: 24 January 2014 Current Price: USD 18.13 Recommendation: SELL

Ticker: KKD Exchange: NYSE Target Price: USD 12.65

Market Profile

52-week price range 12.32 - 26.63

Market Cap 1.25 B

Shares outstanding 66 M

200-day SMAVG 1.41 M

Revenues 435.80 M

EBTDA 47.926 M

Net income 20.78 M

P/E 50.68

P/BV 4.59

ROA 6.05%

ROE 8.43%

Dividend yield 0.00%

Current ratio 2.89%

Institutional holdings 81.42%

Insider holdings 1.01%

Number of employees 4,300

Fiscal Year 2011 2012 2013 2014F 2015F 2016F 2017F 2018F 2019F

Revenues 362.0 403.2 435.8 483.0 527.8 577.2 632.5 688.9 747.5

EBITDA 26.6 34.6 47.9 57.4 62.9 69.0 75.8 82.8 90.0

Net Income 7.6 166.3 20.8 28.4 33.2 38.6 43.0 45.1 48.9

Earnings per share 0.11 0.45 0.31 0.42 0.49 0.58 .066 0.70 0.76

Dividends per share 0.00 0.00 0.00 0.00 0.00 0.00 0.20 0.25 0.30

Return on Assets 4.5% 49.6% 6.1% 8.2% 8.5% 9.1% 9.3% 8.9% 8.8%

Return on Equity 9.9% 66.7% 8.4% 10.6% 10.9% 11.6% 11.8% 11.4% 11.2%

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30KKD daily stock pr ices

Last Price

Target Price

Valuation DCF Multipliers

Estimated Price 10.30 15.00

Weights 50% 50%

Target Price 12.65

Sources: Company Data


Sources: Bloomberg

Change in forecast level of FCFE Change in

WACC -10% -5% 0% 5% 10%

-10% 11.24 11.87 12.49 13.12 13.74

-5% 10.17 10.73 11.3 11.86 12.43

0% 9.27 9.79 10.3 10.82 11.33

5% 8.51 8.98 9.45 9.92 10.4

10% 7.85 8.29 8.72 9.16 9.59

Sources: Team Analyses



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Business Description

Krispy Kreme is a unique doughnut shop that is famous for its signature Original Glazed doughnuts and other Southeast American delectable treats. Established on 13 July 1937 in Winston Salem North Carolina, Krispy Kreme has touched and en-hanced lives of consumers through the taste and joy of high quality doughnuts for 76 years. Krispy Kreme uses a secret yeast-raised recipe and their own doughnut-making equipment to produce goods for consumers via walk-in, drive thru, and through wholesale distribution channels. Krispy Kreme is recognized as a 20th century American icon and was inducted into the Smithsonian Institution’s National Muse-um of American History in 1997. Krispy Kreme issued an initial public offering in 2000 under the ticker KKD and now operates 812 stores in 38 states and 21 other countries through company owned stores and franchisees. Their goal is to have 1300 stores by the end of fiscal 2017. KKD went through retrenchment from 2004 through 2009 due to 240 domestic store closings from unsustainable sale volumes resulting from over expansion which saturated the market, USD 300 million in impairment costs and lease termi-nation costs plus an accounting scandal. KKD has since rebounded and growth has returned powered by strong franchising efforts, new management, international growth, the hub and spoke distribution system and their original one-of-a-kind brand experience. Company Stores. This segment comprises doughnut shops operated by the Com-pany. They sell doughnuts and complementary products through on-premise and wholesale channels. They come in two formats: Factory stores and satellite shops. Factory Stores have a doughnut making production line which serves on-premises and wholesale customers as well as satellite shops. Satellite shops only serve on-premises customers and include the hot shop and fresh shop formats. As of 3 No-vember 2013, KKD operated 94 Company shops in 19 states + D.C., primarily in the southeastern United States, of which 75 are factory and 19 are satellite. Eighty-eight percent of total retail sales resulted from doughnuts. The rest came from beverage sales. Company stores represented 68.03% of total revenues in FY 2013. Domestic Franchise. KKD’s franchise segment offers the same products in the same formats as company stores. As of 11/3/2013, there were 155 franchise oper-ations in 30 states consisting of 106 factory stores and 49 satellite shops. KKD plans to open 400 new domestic shops by 2017 mainly in the southeast. Franchise agree-ments are signed for 15 year renewable contracts. This segment stimulates reve-nues from store startups and franchise fees ranging USD 25,000 to 50,000 as well as 4.5% royalties of on-premise sales and 1.5% of wholesale sales. Royalty reve-nues recognized by the company totaled approximately USD 2.68 million in Q3 2013. Domestic franchises accounted for 2.37% of total revenues in FY 2013. International Franchise. As of 11/3/2103, there were 563 Krispy Kreme stores operated outside of the United States, 123 factory and 440 satellite. The interna-tional franchise pioneered the transformation to smaller format stores through the hub-and-spoke distribution system. The international segment represents 68% of KKD’s total store count, all of which are operated by franchisees. Franchisees pay annual royalties and a one-time development fee ranging between USD 20,000 and 50,000. Royalties are based on 6% of total net sales generated by international stores as well as 0.25% contributable to the KKD brand fund. Total Royalties paid to the company totaled USD 5.81 million in Q3 2013. Royalties payable to KKD by international franchisees are based on a conversion of local currencies to U.S. dol-lars using the prevailing exchange rate. The international segment has been the strongest source of growth fueled by expansion mainly in the Middle East, Asia and South America. Their goal is to have 900 international stores by 2017. International


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stores represented 5.72% of total revenue in FY 2013. KKD Supply Chain: Krispy Kreme operates its own supply system primarily in Winston Salem, North Carolina. KKD supplies ingredients, equipment, doughnut mix, packaging and other operation materials to its domestic and international stores. Management believes this maintains consistency and quality across the board. They have 100% outsourced shipment of supplies through independent distributor contractors in order to increase profitability and reduce export risks. Domestic stores purchase everything from the KKD supply chain while the interna-tional stores mainly purchase the product mix and add with local ingredients. As the Krispy Kreme brand grows domestically and internationally, revenues from increasing sales volumes should rise substantially. KKD Supply Chain accounted for 23.88% of total revenues in FY 2013.

Current Strategy

Hub and spoke model: KKD has been transforming their shop distribution sys-tem by building small satellite shops that surround large factory shops. These smaller shops do not produce doughnuts onsite. They rely on the factory to bring in doughnuts by trucks daily. These smaller hot shops keep doughnuts warm and fresh while cutting the fixed costs of manufacturing equipment.

Innovation and technology: KKD is implementing a new POS system to more effectively support business operations through improved cash controls, en-hanced sales visibility and centralized data management. The new system is scheduled for completion by the end of FYE 2014. KKD has also deployed new handheld software and devices to cut back paper costs and reduce transaction time with wholesalers.

Broader menu of one-of-a-kind products: Besides their signature original glazed doughnuts, KKD has been expanding its menu of products to now over 16 different varieties. Seasonal offerings have become more popular with the in-troduction of the pumpkin spice doughnut and other limited time offerings. KKD also offers complementary products such as coffee and other beverages as well as baked creations which are a special international segment that offers exclusive sweets favored by local consumers in order to penetrate markets around the world.

Domestic expansion and continued international development: KKD has seen significant expansion in markets across the globe. Their goal of 1300 stores by 2017 will require a strong push of capital investment and franchise efforts. Do-mestic expansion will focus mainly in the southeast and primarily through fran-chise developments. Internationally, KKD plans to expand in Asia markets and South America. Successes in these markets are critical for future growth.

Management KKD went into a complete management overhaul during the retrenchment period. James Morgan, Jr. took over as Chairman in 2005 and later became CEO in 2012. Jeffrey Welch is the President of International Operations and Douglas Muir is the Executive Vice President and CFO. Cynthia Bay is the Senior Vice President of U.S. franchises and Michael Wall is the Senior Vice President of the supply chain. The team’s initiative is to spread joy to their consumers and add value for their share-holders and they are very active with maintaining a positive image. This manage-ment team has nearly extracted KKD from retrenchment mode and has sent the enterprise through a remarkable recovery that has the potential to keep growing. The share price of KKD has rebounded from a low of USD 1.08 in 2009 to 19.25 today, a grand 1,682% turnaround.

Industry Overview and Competitive Positioning

One-of-a-Kind Taste The most significant factor Krispy Kreme has in their favor is the delicious taste of


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their original glazed doughnuts. The secret yeast-raised recipe is unique and in a league of its own. These doughnuts have a documented “addictability” that consumers crave for beyond any other restaurant chain. This one-of-a-kind taste builds brand loyalty because consumers know they can only satisfy their craving at Krispy Kreme. Doughnut Theater Krispy Kreme has solidified their brand with the implementation of the dough-nut theatre in most factory shops. Behind glass walls, consumers can watch the production process first hand as employees mix ingredients and create the doughnuts which then are placed on a conveyor belt that moves the product through an oven and through a waterfall of icing to finish off the perfect doughnut. The doughnut theatre is a wonderful attraction for consumers of all ages to see the production process and know without a doubt that the dough-nuts are hot and fresh. These factories can roll out 150 to 230 doughnuts per hour and also supply satellite shops with fresh products. Hot Krispy Kreme Original Glazed Now® Sign. The hot and ready now sign glows bright when the original glazed doughnuts are hot and fresh. This signature trademark advertises KKD’s most popular product which management says is an impulse purchase generator. In 2012, KKD created the Hot Light app for smartphones to automatically notify con-sumers when and where a Hot Light sign is activated. Implementing this fea-ture shows KKD is taking steps to invest in technology in order to reach out to its consumers in new and efficient ways. Over 300,000 people have download-ed the Hot Light app. Sharing and Connecting KKD holds a rich heritage for being a leader in bringing joy to the community. The melt-in-your-mouth taste of a hot original glazed doughnut is most en-joyed with others. Approximately 70% of purchases are for sharing occasions and approximately 55% of transactions are for sales of one or more dozen doughnuts. KKD also supports local communities through supplying fundrais-ing opportunities for charities and schools. Stable community involvement strengthens KKD’s brand name and serves as a sales driver. Sugar price Futures contract prices on sugar have declined 20% between October 2013 and January 2014, due to a global increase in supply. Global production out-look improves as excess supply builds up which drives down the price. Brazil is the largest producer of sugar in the world followed by India and China. De-mand has increased strongly from ethanol production for biofuel. Brazil’s pro-duction is at full capacity which has improved to 83.7 tons of sugar cane per hectare from 75.9 tons in 2012 due to technology improvements. The low cost of sugar, one of KKD’s main ingredients, makes doughnut production cheaper.

Coffee Sales KKD has broadened its product mix with the addition of their own signature coffee brand that is offered in many styles, hot and cold. KKD started to offer 40-ounce packages in 100 Sam’s Club throughout southeast as a test program with royalties paid to KKD. Management hopes to provide consumers with the joy of Krispy Kreme in the comfort of their own home. Coffee sales are up 15% from a year ago. The cost of coffee beans can affect their input price. A supply glut decreased the price by 20% last year bringing the C-contract future price at USD 120 marking a 3-year consecutive decrease. The surplus in supply is expected to continue due to solid crop conditions in Brazil and Colombia.

Emerging markets


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KKD has launched an international franchise expansion that has been globally gaining ground. KKD plans to open 114 stores in India, the world’s second larg-est country by population, between 2 franchisees. Thirty five stores will be operated by Bedrock Foods Co. in the capital of Delhi and other cities in north-ern India. Bedrock is rolling out eggless doughnuts to cater to Indian consum-ers who don’t eat eggs due to faith-based dietary restrictions. India has strong growth, urbanization and disposable income. Sixty percent of raw materials will come from the domestic market, the rest will be imported from the U.S. KKD is also opening 15 shops in Singapore and 25 shops in Colombia, which marks KKD’s first entrance into South America. They also just signed a develop-ment contract for 23 new stores in China. KKD plans to meet their 900 interna-tional shop goal by January 2017. Domestic market KKD is primarily focusing on small freestanding factory shops for company stores. They have opened seven so far this year, including two in Q3 2013 in metro Atlanta and plan to open two additional shops in the fourth quarter. Their goal is to reduce operating cost without sacrificing customer experience as well as lower investment cost. The majority of growth will be through fran-chise. KKD set a franchise agreement to develop four shops in Alaska over the next three years, 10 stores in Houston and a 15 store development agreement for Dallas, Texas. KKD’s goal of 400 domestic stores by January 2017 was made two years ago and development has been slower than forecasted, but the slower speed may permit the company to improve store locations and as such, limit cannibalized sales.

Competitors Krispy Kreme operates within the quick service restaurant, or QSR, segment of the restaurant industry. KKD competes with other QSR bakeries and coffee shops as well as wholesalers. Dunkin Doughnuts (DNKN), Starbucks (SBUX) and Panera Bread (PNRA) are KKD’s biggest competitors. They all compete for con-sumer’s snack time by offering baked goods and coffee. They globally posi-tioned themselves to compete with each other worldwide.

Investment Risks

Interest Rate Risk Krispy Kreme is exposed to market risk from increases in interest rates on its outstanding debt. On 3 March, 2011 the company entered into an interest rate derivative contract having an aggregate notional principal of USD 17.5 million. The contract entitles Krispy Kreme to receive from the counterparty the ex-cess, if any, of 3 month LIBOR over 3% for each of the calendar quarters ending December 2015. The company is accounting for this derivative contract as a cash flow hedge. Mitigation: As of 4th quarter 2013, Krispy Kreme had only USD 1.632 million remaining in debt outstanding.

Currency Risk The majority of the company’s revenue, expense, and capital purchasing activi-ties are transacted in U.S. dollars. Royalties from international franchises are computed based on local currency sales and changed in the rate of exchange between US dollars and the foreign country’s currency. During FY 2013, inter-national franchisees had sales of approximately USD 243 million, mainly from India and South Korea, and the company’s related royalty revenues were ap-proximately USD 23 million. (A 10% change in the average rate of exchange between the US and foreign currencies would affect royalty revenues by USD 2.3 million) Macro Risks


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High unemployment, low consumer confidence, tightened credit and other fac-tors have taken their toll on consumers and their ability to increase spending, resulting in fewer visits to restaurants and related dollar growth of sales. As a result, QSR sales may continue to be adversely impacted by the weak economic environment or by sharp increases in commodity or energy prices. The Company believes increased prices of agricultural products and energy are more likely to significantly affect its business than are economic conditions generally, because the Company believes its products are affordable indulgences that appeal to con-sumers in all economic environments. Glaze Flavoring Risk Krispy Kreme has only one supplier of glaze flavoring and any interruption in the supply could affect the ability to produce their signature hot Original Glazed doughnut.

Commodity Price Risk The risk of unexpected fluctuations in the price of commodity production inputs for Krispy Kreme (Main Ingredients: flour, shortening, sugar, gasoline) can reduce the company’s profit margins. Factors that can affect commodity prices include political and regulatory changes, seasonal variations, weather, technology and market conditions. Mitigation: Krispy Kreme routinely enters into forward pur-chase contracts, future contracts and options on such contracts, ranging from 1 month to 2 years depending on the ingredient (But do not fully mitigate com-modity price risk). Disruption of Supply Chain This arises from any incidents that may affect the main distribution center of Krispy Kreme in Winston Salem, such as damages due to natural disasters. Miti-gation: The Company has decreased risk of over dependence on a single distri-bution center by establishing more distribution centers across the United States in Mira Loma, California and Effingham, Illinois. Technology Risk Technology systems are vital to the efficiency of Krispy Kreme’s operations and distributions. Mitigation: In fiscal 2012, the company purchased new point-of-sale hardware for all Company shops and established a new standard hardware configuration for Company and domestic franchisee locations. In fiscal 2013, Krispy Kreme tested new front-of-house and back-of-house point-of- sale soft-ware to more effectively support the business through improved cash controls, enhanced sales visibility and centralized data management. In early fiscal 2014, the company began deployment of the new POS software to Company shops, and expects to complete that deployment, together with deployment to certain domestic franchise shops, in fiscal 2014. In fiscal 2015, Krispy Kreme plans on leveraging the new software to launch a domestic system-wide loyalty program, improve inventory management and centralize national promotions for Company and domestic franchisee locations. Political/Regulatory Risks As a franchisor, Krispy Kreme is subject to regulation by the FTC and by domestic and foreign laws regulating the offer and sale of franchises. The company’s abil-ity to develop new franchised stores and to enforce contractual rights against franchisees may be adversely affected by these laws and regulations, which could cause franchise revenues to decline (especially since the company plans to grow primarily through franchising). Trademark Risk


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Krispy Kreme’s trademarks and other intellectual property rights are important to their success and competitive position. The company owns certain common-law trademark rights and have a system in place that is designed to detect po-tential infringement of their trademarks, but may not be sufficient in some juris-dictions outside the U.S. (specifically Costa Rica, Guatemala, India, Indonesia, Nigeria, Peru, the Philippines and Venezuela). Such uses could adversely affect the value of Krispy Kreme’s trademarks. Healthcare Legislation Risk Federal legislation regarding government-mandated health benefits is expected to increase Krispy Kreme’s franchisee costs. The company’s results of operations, financial position and cash flows could be adversely affected. Conflicts with Franchisees A portion (approximately 9%) of Krispy Kreme’s revenues comes from the sales of franchisees, who account for more than 87% of the total Krispy Kreme stores. Franchisees will also serve a primary means of future expansion domestically and internationally. Any conflict of interest with them will adversely affect Krispy Kreme’s brand name and growth. Mitigation: Krispy Kreme is committed to de-voting additional resources and providing an even higher level of support to both domestic and international franchisees in beginning FY 2014. Krispy Kreme Uni-versity, the company’s training operation, is available to franchisee assistant managers and general managers, and International Franchise personnel also provide training to franchisees around the world. Corporate Social Responsibility It is important for Krispy Kreme to maintain its corporate image and brand value by taking initiative to asses and take responsibility for the company’s effects on the environment and impact on social welfare. The company complies with the Corporate Governance Guidelines and the Code of Business Conduct and Ethics. Krispy Kreme also sponsors several fundraising events such as “doughnut day” that can earn schools thousands of dollars. Another way that the company dis-plays CSR is switching to cage-free eggs. In 2012 the Company's shareholders approved the Krispy Kreme Doughnuts, Inc. 2012 Stock Incentive Plan (named "2012 Plan"). This Plan, which expires in 2022, limits issuance of shares of Company common stock to approximately 3,550,000 shares. Another portion was a tax asset protection plan intended to preserve the company's federal net operating loss and other tax carryforwards, which currently represent the largest asset to the Com-pany. In order to protect these assets the Company will limit common shares held to no more than 5% owned by any one shareholder. According the this plan, the Company de-clared a dividend of one preferred share purchase right for each outstanding share of its common stock payable. In order to execute any future share buybacks, the Company must have the leverage ratio not greater than 2.0 and the fixed charge coverage ratio not less than 1.5. Which is will maintain over the forecasted years.

Investment Summary

Volatile Stock with Potential for High Growth DuPont Analysis This analysis provides a deeper understanding of KKD’s ROE and breaks it down into operating efficiency, asset utilization and financial leverage. Each of these components influence a company’s ROE. Net profit margin is seen to grow to and remain stable at 6.5% through 2019. Asset utilization is forecasted to in-crease to 6.38% by 2019. The equity multiplier is decreasing due to KKD becom-ing unlevered. ROE is projected to rise to 11.16% by 2019, which shows the first two components overpower the decrease in the equity multiplier. Valuation Methods


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We have derived our final target price by equally weighting the DCF valuation and multiple pricing. In our opinion, we feel there are no discrepancies to cause une-qual weighting of the two valuation methods. The selection was our peer group was carefully chosen in respect to competition, products, and market share. Out of all of the comparables KKD represent the highest risk as reflected in the beta. New Growth Model KKD has decided to take advantage of lower operating costs by switching the com-pany owned store model to building new smaller factory stores. With an anticipat-ed 7-10 new stores each year is the main driver of growth in company revenues. The company has substantial contracts in place for international growth which may be the main driver behind the company sales growth over all in the future, after adjusting for the current decline in same store sales. Steps have been taken to out-source transportation and some mix formulation to reduce operating costs in the supply chain. Consumer Discretionary Trends Last year the convenience store doughnut market contracted more than 2% while Krispy Kreme’s revenues rose 7.4%. The outlook for consumer spending is improv-ing although growth is weakening in some large emerging economies and slowing the sales for large companies. Several trends are boosting consumer spending in developed countries: Inflation is low, enabling consumers to stretch their money.

In the United States, Morgan Stanley economists forecast that consumer spending rose in the final three months of the year at its fastest pace in three years. . Accord-ing to the Thomson Reuters/University of Michigan sentiment index consumer con-fidence is currently at its highest since July 2013 showing consumer are even more positive about the economic outlook. The S&P/Case-Shiller index also highlights consumers are more willing to spend money as it reached the largest year-over-year it has seen since 2006. With more consumers willing to open their wallets, businesses will also likely start spending more on machinery, computers and other equipment, providing an additional spark to growth. In international concerns, In-dia and Brazil have been raising interest rates to battle high inflation. Both high rates and rising prices are weighing on consumer spending in those countries.

Valuation

We evaluated KKD using two techniques: Discounted Cash Flow (DCF) and Multiple Analysis. Discounted Cash Flow Model : Free Cash Flow to Equity (FCFE) We found the FCFE approach to be appropriate since the company is essentially debt-free. Revenues were projected on a per-store per-year basis until FY2019. The four key inputs for the DCF model to FCFE are revenue projections for: 1) Com-pany Stores 2) Domestic Franchise 3) International Franchise 4) KK Supply Chain. Sales Forecast Cash flows projected from FY14-19 are based on the KKD’s aggressive international expansion plans, an intensified focus on domestic expansion, and increased do-mestic same store sales. Management’s current goal is to have 900 international and 400 domestic system-wide stores by fiscal 2017. As of 3 Nov 2013, KKD had 249 domestic stores and 563 international stores in operation. New Small Factory Store Format The company has identified their new small factory store format as the driver of their domestic company store growth. This new model was designed to be more efficient, with decreased production capacity, lower fixed costs, and a lower break-

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2009 2010 2011 2012 2013 2014Company Domestic Franchise


Table 1 : Same Store Sales Growth (Decline) by Business Segment FY2009-2014


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even point. As of 3 November 2013, the company had 7 of these new stores in operation. Management estimates that 10-15 free-standing company shops will be built in fiscal 2015. Same Store Sales Domestic same store sales exhibited strong increases over the last four years, while international same store sales have weakened. We projected that this trend would continue domestically over the forecasted years. International same store sales are projected to continue to decline initially, with the assumption that they would eventually grow over time as a result of KKD’s growing global presence. CAPEX Due to the company’s plan to accelerate domestic company store growth, capital expenditures for fiscal 2014—2017 are projected to be elevated from previous years, averaging at USD 23.5 million per year . Cost of Equity The cost of equity was calculated using the CAPM Model. We used the 10-year

government bond risk-free rate of 2.82% and a market risk premium of 6.43%. We calculated the 2013 beta (KKD USD price regressed against the S&P SmallCap 600) relevered for decreased long-term debt, then adjusted for forecasting. This result-ed in an adjusted beta of 1.65 and Cost of Equity of 13.43%. Risks to target price The DCF is mostly reliant on the Terminal Value, which is heavily dependent on the assumed perpetual growth rate. Peer Group Pricing Three competitors were chosen as the appropriate peer group for which we con-ducted multipliers pricing using benchmark P/E and EV/EBITDA ratios, both based on four two-year forward medians. We estimated that KKD’s market value was priced at a premium relative to its peers for a period of five observed years.

We noted the following factors supporting this premium in previous years:

Investors have stayed positive during company recovery and have focused on new growth prospects.

Earnings per share have remained low in comparison to KKD’s peer group. The average historical P/E premium above the peer group is 27%. We normalized EPS for FY 2012 to adjust for the recognition of USD 139 million of deferred tax assets. In FY 2013, KKD experienced a substantial increase in P/E compared to its competitors, largely driven by positive investor reactions to a USD 20 million share buyback, 8% growth in revenues, and 19% increase in EBT. It is predicted that this increase will not be sustained at this high level. We forecasted that the P/E will fall between 35.0 to 38.0 over the next two years.

Cost of Equity Assumptions

Adjusted Beta 1.65

Risk-free rate 2.82%

Market risk premium 6.43%

Equity risk premium 10.61%

Cost of Equity 13.43%


Fiscal 2014E 2015E 2016E 2017E 2018E 2019E

Net Income 20.78 28.42 33.24 38.55 43 45.06

Cash flow from operations 52.09 60.83 68.88 76.51 83.57 96.77

Fixed capital investment -25 -25 -23 -21 -13 -11

Net borrowings 1.6 -

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FCFE $28.69 $35.83 $45.88 $55.51 $70.57 $85.77

Terminal Growth Rate 5%

Perpetuity WACC 13.43%

Residual Value 1,067.99

PV of Residual Value 501.34

PV of FCF 195.94

Enterprise Value 697.29

Net Debt 0

Value of Equity 697.29

Number of Shares (mn) 67,692

Share Price end FY 2014 $ 10.30


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In respect to EV/EBITDA, KKD is trading at a very small discount of less than 1% to its peer group. KKD’s EV/EBITDA has experienced high volatility over the historical five years in relationship to the peer group average. Given that the P/E multiples of KKD and its comparables have demonstrated a more stable trend, we have de-cided to attribute 75% weight toward this multiple price and the remaining 25% to the EV/EBITDA multiple price. The result was a final multiple valuation price of USD 15.00. It is important to note that there are only two years of historical data on Dunkin Donuts. Given that, we feel their multiples fall right in line with the comparables average, and we do not predict huge fluctuations from the trend as, even though newly public, the company has been well established for over six decades. Weighting of the Models

Financial Analysis

Earnings For KKD, FY 2012 demonstrated an enormous increase of net income which result-ed mainly from a recognition of USD 139 million in deferred tax assets. That year pretax income did see a 243% growth, much of this was driven by an 11% increase in sales, while cutting back on cost of revenue, and significantly decreases oper-ating costs down to a 3% growth. This success in management is a positive sign of the company’s ability to become more efficient during its period of recovery and entering back into a strong growth strategy. In addition to efficiency, the company has also relied on its exclusion to tax ex-penses to maintain a steady earnings throughout the recovery stage. According to forecasting, the company will maintain a strong growth of net income during the next two years which will increase at a decreasing rate as the company once again begins to pay more normalized tax expenses. In addition to taxes, a USD 5 million expense predicted by the company has also been factored in each year for the newly instated Affordable Care Act. Level of Margins Over the next few years we can expect to see increases in revenues as the compa-ny continues to attempt to return international same store sales growth to a posi-tive level after which it will also increase as a decreasing rate as concentration risk begins to effect expansion rate. Revenue growth stays fairly stable at an increase of nearly 9% each year over the forecasted time period. The increases in gross profit margins and operating margins will also increase at a decreasing rate as the company maxes out efficiency in cost management.


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Appendix 1: Statement of Financial Position

Balance Sheet (USD '000,000)

Assets Fiscal 2011 2012 2013 2014E 2015E 2016E 2017E 2018E 2019E

Cash & Near Cash Items 21.97 44.32 66.33 85.19 120.55 138.96 143.56 149.98 157.33

Short-Term Investments 0.00 0.00 0.00 0.00 0.00 15.00 40.00 75.00 125.00

Accounts & Notes Receivable 20.26 21.62 25.63 28.40 31.04 33.94 37.19 40.51 43.96

Inventories 14.64 16.50 12.36 13.70 14.97 16.37 17.94 19.54 21.20

Other Current Assets 6.56 14.81 30.47 33.76 36.90 40.35 44.22 48.16 52.26

Total Current Assets 63.42 97.24 134.78 161.05 203.46 244.61 282.91 333.19 399.74

LT Investments & LT Receivables 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

Net Fixed Assets 71.16 75.47 78.02 83.49 89.33 95.58 102.27 109.43 117.09

Gross Fixed Assets 139.81 148.10 149.60 160.07 171.28 183.27 196.10 209.82 224.51

Accumulated Depreciation 68.65 72.63 71.58 76.59 81.95 87.68 93.82 100.39 107.42

Other Long-Term Assets 35.34 162.24 129.13 103.25 99.17 93.69 79.79 63.78 39.41

Total Long-Term Assets 106.50 237.71 207.15 186.74 188.50 189.27 182.06 173.21 156.50

Total Assets 169.93 334.95 343.38 347.78 391.96 425.89 464.97 506.41 556.24

Liabilities & Shareholders' Equity

Accounts Payable 9.95 10.49 12.20 13.52 14.77 16.15 17.70 19.28 20.92

Short-Term Borrowings 2.51 2.22 2.15 2.26 2.37 2.49 2.61 2.74 2.88

Other Short-Term Liabilities 28.38 28.80 32.33 35.83 39.16 42.82 46.92 51.11 55.46

Total Current Liabilities 40.85 41.52 46.68 51.60 56.30 61.46 67.24 73.13 79.26

Long-Term Borrowings 32.87 25.37 23.60 0.00 0.00 0.00 0.00 0.00 0.00

Other Long-Term Liabilities 19.78 18.94 25.24 27.00 28.89 30.91 33.08 35.39 37.87

Total Long-Term Liabilities 52.65 44.30 48.83 27.00 28.89 30.91 33.08 35.39 37.87

Total Liabilities 93.50 85.82 95.51 78.60 85.19 92.37 100.32 108.53 117.13

Minority Interest 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

Share Capital & APIC 370.81 377.54 354.07 347.89 353.48 341.48 329.48 317.48 309.65

Retained Earnings & Other Equity -294.38 -128.41 -107.64 -79.22 -47.39 -8.84 34.15 79.22 128.08

Total Equity 76.43 249.13 246.43 268.68 306.09 332.64 363.63 396.69 437.73

Total Liabilities & Equity 169.93 334.95 341.94 347.28 391.28 425.01 463.95 505.22 554.86


13

Appendix 2: Income Statement

(USD '000 000) Fiscal 2011 2012 2013 2014E 2015E 2016E 2017E 2018E 2019E

Revenues 361.96 403.22 435.80 482.96 527.82 577.17 632.51 688.94 747.52

COGS 313.48 346.43 362.83 392.40 428.85 468.95 513.92 559.77 607.36

Gross Profit 48.48 56.78 73.02 90.55 98.97 108.22 118.60 129.18 140.16

Operating Expenses 29.26 30.42 34.98 43.64 47.23 51.17 55.60 60.12 64.80

Operating Income (EBIT) 19.22 26.36 38.04 46.92 51.74 57.05 63.00 69.06 75.36

Interest Expense 6.36 1.67 1.64 0.00 0.00 0.00 0.00 0.00 0.00

Foreign Exchange Losses (Gains) 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

Net Non-Operating Losses (Gains) 4.01 -5.66 0.08 0.00 0.00 0.00 0.00 0.00 0.00

Pretax Income (EBT) 8.86 30.36 36.32 46.92 51.74 57.05 63.00 69.06 75.36

Income Tax Expense 1.26 -135.91 15.54 18.50 18.50 18.50 20.00 24.00 26.49

Net Income 7.60 166.27 20.78 28.42 33.24 38.55 43.00 45.06 48.87


14

Appendix 3: Statement of cash flows

Fiscal 2011 2012 2013 2014E 2015E 2016E 2017E 2018E 2019E

Cash From Operating Activities

Net Income 7.60 166.27 20.78 28.42 33.24 38.55 43.00 45.06 48.87

Depreciation & Amortization 7.39 8.24 9.89 10.47 11.21 11.99 12.83 13.73 14.69

Other Non-Cash Adjustments 6.99 -137.75 23.85 7.89 10.58 12.00 13.73 17.21 25.00

Changes in Non-Cash Capital -1.47 -2.89 4.79 5.31 5.80 6.35 6.95 7.57 8.22

Cash From Operations 20.51 33.86 59.31 52.09 60.83 68.88 76.51 83.57 96.77

Cash From Investing Activities

Disposal of Fixed Assets 2.95 0.04 0.18 0.00 0.00 0.00 0.00 0.00 0.00

Capital Expenditures -9.69 -11.88 -14.22 -25.00 -25.00 -23.00 -21.00 -13.00 -11.00

Other Investing Activities -1.83 9.32 -0.40 0.00 0.00 -0.017 -0.044 -0.083 -0.137

Cash From Investing Activities -8.57 -2.52 -14.44 -25.00 -25.00 -23.02 -21.04 -13.08 -11.14

Cash from Financing Activities

Dividends Paid 0.00 0.00 0.00 0.00 0.00 0.00 -13.40 -16.75 -20.10

Change in Short-Term Borrowings 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

Increase in Long-Term Borrowings 35.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

Decrease in Long-term Borrowings -43.26 -8.99 -2.35 -1.60 0.00 0.00 0.00 0.00 0.00

Increase in Capital Stocks 0.01 1.04 0.26 0.00 0.00 0.00 0.00 0.00 0.00

Decrease in Capital Stocks -0.58 -1.00 -20.76 -6.17 0.00 -12.00 -12.00 -12.00 -7.83

Other Financing Activities -1.35 -0.03 -0.01 -0.46 -0.46 -0.46 -0.46 -0.32 -0.36

Cash from Financing Activities -10.18 -8.99 -22.86 -8.23 -0.46 -12.46 -25.86 -29.07 -28.29

Net Changes in Cash 1.76 22.35 22.01 18.86 35.37 33.40 29.60 41.42 57.34


15

Appendix 4: Key Financial Ratios

Fiscal 2011 2012 2013 2014E 2015E 2016E 2017E 2018E 2019E

Liquidity Ratio

Current Ratio (x) 1.55 2.34 2.89 3.11 3.60 3.97 4.19 4.54 5.03

Quick Ratio (x) 1.19 1.94 2.62 2.85 3.34 3.70 3.93 4.27 4.76

Cash Ratio (x) 0.54 1.07 1.42 1.64 2.13 2.25 2.12 2.03 1.97

Efficiency Ratio

Total Asset Turnover (x) 5.09 5.34 5.59 5.78 5.91 6.04 6.18 6.30 6.38

Fixed Asset Turnover (x) 2.59 2.72 2.91 3.02 3.08 3.15 3.23 3.28 3.33

A/R Turnover 19.00 19.26 18.45 17.88 17.76 17.76 17.78 17.73 17.70

Collection Period 19.21 18.95 19.78 20.42 20.55 20.55 20.52 20.58 20.62

Inventory Turnover (x) 24.73 24.44 35.26 35.26 35.26 35.26 35.26 35.26 35.26

Days in Inventory (days) 17.04 17.38 12.43 12.74 12.74 12.74 12.74 12.74 12.74

Payables Turnover (x) 37.92 34.02 32.33 30.73 30.50 30.51 30.55 30.45 30.38

Payables period (days) 11.59 11.06 12.27 12.57 12.57 12.57 12.57 12.57 12.57

Operating Cycle (days) 24.45 25.58 18.61 18.04 17.93 17.93 17.95 17.90 17.86

Profitability Ratio

Gross Profit Margin (%) 11.48% 10.15% 14.24% 13.39% 14.08% 16.75% 18.75% 18.75% 18.75%

EBITDA 26.61 34.60 47.93 57.39 62.95 69.04 75.82 82.79 90.05

EBIT Margin (%) 1.06% 1.38% 5.10% 5.31% 6.54% 8.73% 9.71% 9.80% 9.88%

EBITDA Margin (%) 7.35% 8.58% 11.00% 11.88% 11.93% 11.96% 11.99% 12.02% 12.05%

Net Profit Margin (%) 2.10% 41.24% 4.77% 5.88% 6.30% 6.68% 6.80% 6.54% 6.54%

ROA (%) 4.47% 49.64% 6.05% 8.18% 8.50% 9.07% 9.27% 8.92% 8.81%

ROE (%) 9.94% 66.74% 8.43% 10.58% 10.86% 11.59% 11.82% 11.36% 11.16%

Solvency Ratio

Debt Ratio (%) 20.82% 8.24% 7.50% 0.65% 0.61% 0.59% 0.56% 0.54% 0.52%

Debt to Equity Ratio (x)

0.463

0.111

0.104

0.008

0.008

0.007

0.007

0.007

0.007

Equity Multiplier (x) 2.223 1.344 1.393 1.293 1.278 1.278 1.276 1.274 1.268


16

Appendix 5: Income Statement (Common-Size)

Fiscal 2011 2012 2013 2014E 2015E 2016E 2017E 2018E 2019E

Total Revenues 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%

Cost of Goods Sold 86.61% 85.92% 83.25% 81.25% 81.25% 81.25% 81.25% 81.25% 81.25%

Gross Profit 13.39% 14.08% 16.75% 19% 19% 19% 19% 19% 19%

Operating Expense 8.08% 7.55% 8.03% 9.04% 8.95% 8.87% 8.79% 8.73% 8.67%

Operating Income (EBIT) 5.31% 6.54% 8.73% 9.71% 9.80% 9.88% 9.96% 10.02% 10.08%

Interest Expense 1.76% 0.41% 0.38% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%

Earnings Before Taxes (EBT) 2.45% 7.53% 8.33% 9.71% 9.80% 9.88% 9.96% 10.02% 10.08%

Tax Expense 0.35% -33.71% 3.56% 3.83% 3.50% 3.21% 3.16% 3.48% 3.54%

Net Income 2.10% 41.24% 4.77% 5.88% 6.30% 6.68% 6.80% 6.54% 6.54%


17

Appendix 6: Balance Sheet (Common-Size)

Fiscal 2011 2012 2013 2014E 2015E 2016E 2017E 2018E 2019E

Cash and Cash Equivalents 12.93% 13.23% 19.32% 24.39% 30.64% 32.49% 30.72% 29.45% 28.10%

Receivable 11.92% 6.45% 7.46% 8.18% 7.93% 7.99% 8.02% 8.02% 7.92%

Inventories 8.61% 4.93% 3.60% 3.94% 3.83% 3.85% 3.87% 3.87% 3.82%

Other Current Assets 3.86% 4.42% 8.87% 9.72% 9.43% 9.49% 9.53% 9.53% 9.42%

Current Assets 37.32% 29.03% 39.25% 46.23% 51.83% 53.82% 52.14% 50.87% 49.27%

Long-term Investments 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%

Net PPE 41.88% 22.53% 22.72% 24.04% 22.83% 22.49% 22.04% 21.66% 21.10%

Other Non-Current Assets 20.80% 48.44% 37.61% 29.73% 25.34% 22.04% 17.20% 12.62% 7.10%

Total Assets 100.00% 100.00% 99.58% 100.00% 100.00% 98.35% 91.38% 85.15% 77.47%

Liabilities and Shareholder Equity

Short-term Borrowing 1.48% 0.66% 0.63% 0.65% 0.61% 0.59% 0.56% 0.54% 0.52%

Accounts and Notes Payable 5.86% 3.13% 3.57% 3.89% 3.78% 3.80% 3.82% 3.82% 3.77%

Other Current Liabilities 16.70% 8.60% 9.45% 10.32% 10.01% 10.07% 10.11% 10.12% 9.99%

Total Current Liabilities 24.04% 12.40% 13.65% 14.86% 14.39% 14.46% 14.49% 14.48% 14.28%

Long-term Liabilities 19.35% 7.57% 6.90% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%

Other Non-Current Liabilties 11.64% 5.65% 7.38% 7.78% 7.38% 7.27% 7.13% 7.01% 6.83%

Total Liabilities 55.02% 25.62% 27.93% 22.63% 21.77% 21.73% 21.62% 21.48% 21.11%

Share Capital & APIC 218.22% 112.72% 103.55% 100.18% 90.34% 80.35% 71.02% 62.84% 55.81%

Retained Earnings and Other -173.24% -38.34% -31.48% -22.81% -12.11% -2.08% 7.36% 15.68% 23.08%

Total Equity 44.98% 74.38% 72.07% 77.37% 78.23% 78.27% 78.38% 78.52% 78.89%

Total Liabilities & Shareholder Equity 100% 100% 100% 100% 100% 100% 100% 100% 100%


18

Appendix 8: Multipliers pricing

2014E 2015E 2014E 2015E

Median P/E for each year 30.14 28.19 EV/EBITDA Peers 15.00 11.47

Applied Discount 27% 27% Applied Discount -0.01 -0.01

Target P/E 38.29 35.81 Target EV/EBITDA 14.90 11.39

EPS 0.42 0.49 EBIT 46.92 51.74

Cash 84.09 119.88

ST Investments 0.00 0.00

Debt 0.00 0.00

Shares Outstanding 67.35 67.35

Value of Equity 699.27 589.49

Price From P/E 16.08 17.54 Price From EV/EBITDA 10.38 8.75

Weight for Years 50% 50% 50% 50%

Weight for Multipliers 75% 25%

Price from Relative Valuation $ 15.00

Weight of Relative Valuation 50%

Price from DCF $10.30

Weight from DCF 50%

Price Per share $12.63

P/E Multiple 2009 2010 2011 2012 2013E 2014E 2015E

PNRA 24.00 27.82 29.40 26.88 29.31 30.14 28.19

DNKN 37.64 27.43 58.05 56.86 57.30

SBUX 20.10 24.25 28.64 32.75 25.82 28.46 28.03

Average P/E for each year 22.05 26.04 31.89 29.02 37.73

KKD P/E 39.32 33.20 17.00 43.94 47.00

Historical Discount 78.3% 27.5% -46.7% 51.4% 24.6%

Average of Historical Premium (2009-2013E) 27%

EV/EBITDA Multiple 2009 2010 2011 2012 2013E 2014E 2015E

PNRA 9.24 11.33 13.19 11.74 13.45 12.43 11.47

DNKN 0.00 0.00 16.04 18.38 29.60 26.91 26.97

SBUX 9.85 12.66 16.42 19.58 14.53 15.00 10.77

Average EV/EBIT each year 9.24 11.33 15.22 16.57 19.19

KKD EV/EBITDA 8.25 16.72 14.45 16.85 12.15

Historical Discount -10.7% 47.6% -5.0% 1.7% -36.7%

Average of Historical Discount (2009-2013E) -0.6%


19

Appendix 9: Business Structure

Business Segment Store Format Operations



20

Appendix 10: Franchise Development Agreements Table 1 : Licensing Terms

Associates Area Developers Recent Franchisees International

Origination

Associates typically have many years of experience operating KK stores and

selling KK products both at retail and wholesale in

defined territories.

In the mid-1990's, the compa-ny franchised territories in the US, pursuant to area develop-

ment agreements.

Since fiscal 2009, the Company has signed several new franchise

agreements. This includes re-newal agreements resulting from contract expirations,

agreements for new stores with existing franchisees and agree-

ments with new franchisees who acquired existing KK franchise and company shops. In addi-

tion, several agreements arose from the conveyance of Compa-

ny markets to franchisees.

Location Mostly in the Southeast US

Territories in the US, usually defined by metropolitan sta-

tistical areas

Territories are typi-cally country or re-gion-wide. For large countries, the devel-

opment territory may encompass only a portion of a coun-

try.

Operations On-premises &

Wholesale On-premises &

Wholesale On-premises

On-premises (except wholesale Canada, Australia,

and UK)

Growth

Concentrate on growing sales within the current

base of stores rather than new store development.

Specified under terms of the agreement

Specified under terms of the agreement

Specified under terms of the agree-

ment

Licensing Agreement

Possess exclusive right to open new stores in their

geographic territories, but no obligation to develop

additional stores.

Agreement specifies the num-ber of stores to be developed in an area. Related franchise

agreements govern the opera-tion of each store.

Some of the recent franchisees have signed development

agreements, requiring them to build a specified number of

stores in an exclusive geogra-phy within a specified time period, usually five years or

less.

Restrictions

Company cannot grant new franchises or sell any KK

branded products within an associate's territory during

the term.

Possess the exclusive right to sell KK branded products

within a 1-mile radius of their stores and in wholesale ac-counts that they have ser-

viced in the last 12 months.

These agreements generally allow the Company to sell KK

branded products in close geographic proximity to the

franchisees' stores.

Expiration Most current agreements

expire in 2020.

Most of these agreements have expired, been terminat-ed or renewed with territorial

and store-count (build out) modifications.

Term 15 years

Renewable

15 years Renewable provided the

franchisee meets specified criteria

15 years Renewable



21

Table 2: Royalty Structure and Fees

Associates Area Developers Recent Franchisees International

On-premises Sales

3%

4.50% Same as Area Developer 6%

All Other Sales 1%

4.5% In recent years, the Compa-ny has elected to reduce the

royalty rate on wholesale sales. The Company current-ly charges Area Developers a royalty rate of 1.5% whole-

sale sales.

Same as Area Developer 0.25%

Contribution to Brand Fund

1% 1% 1% 1%

Fees

Generally permitted to open KK shops within

their geographic territo-ries without the pay-ment of any develop-

ment fee or initial fran-chise fee.

Recent domestic develop-ment agreements generally provide for the payment of

one-time initial development and franchise fees ranging from USD 25,000 - 50,000

per store.

Recent domestic develop-ment agreements generally provide for the payment of

one-time initial development and franchise fees ranging from USD 25,000 - 50,000

per store.

One-time development & franchise fees from USD 20,000 - 50,000

per store

% of USD 281 million

Domestic Franchisee

FY2013 Sales

Approx. USD 84 million or 30%

Approx. USD 197 million or 70%

N/A

FY2013 Aggregate

Royalty Revenue

Approx. USD 2 million

Approx. USD 7.7 m



22

Appendix 11: Methods for Forecasting Company Revenues Phase 1: Forecasting Store Growth When forecasting the number of future stores that would be built for each year from FY14-19, we began by averaging the number of future commitments over the number of years left before the contract expired and assigning them to each year accordingly.

Cells A1:F8 show the number of additional stores (average) that we expect to be built in each state per fiscal year.

Column G shows the change in actual store count observed from FY12-13.

Column H shows the increase or decrease in future store commitments reported in FY13 versus FY12.

Column I shows the estimated additional amount contracted during FY13, based on observations in Columns G and H. Table 1: Domestic Franchise Future Store Commitments Distributed Over Agreement Life

A B C D E F G H I

Fiscal Year 2012A 2013A 2014E 2015E 2016E 2017E 2018E 2019E Change in

Store Count Change in

Commitments Additional Contracted

1 Arizona 1 3 1 1 2 -2

Agreement Amount By Fiscal Expiration Year

2013 2

2012 4

2 California 17 20 3.67 3.67 3.67 3 6 9


2013 11

2012 5

3 Colorado 2 2 2.6 2.6 2.6 2.6 2.6 0 13 13


2013 13

2012 0

4 New Mexico 2 3 1 1 1 -1 0


2013 2

2012 3

5 North Carolina 8 8 1 1 1 0 0 0


2013 3

2012 3

6 Pennsylvania 8 8 3.4 3.4 3.4 3.4 3.4 0 0 0

Agreement Amount By Fiscal Expiration Yr

2013 17

2012 17

7 South Carolina 9 9 2 0 0 0


2013 2

2012 2

8 Texas 9 9 1.3 1.3 1.3 0 4 4

2013 4 Agreement Amount By Fiscal Expiration Year 2012 0

Total 26 Sources: Company Data, Team Analyses


23

Cells A1:F12 show the number of additional stores (average) that we expect to be built in each country per fiscal year.

Column G shows the change in actual store count observed from FY12-13.

Column H shows the increase or decrease in future store commitments reported in FY13 versus FY12.

Column I shows the estimated additional amount contracted during FY13, based on observations in Columns G and H. Table 2: International Franchise Future Store Commitments Distributed Over Agreement Life

A B C D E F G H I

Fiscal Year 2012A 2013A 2014E 2015E 2016E 2017E 2018E 2019E Change in

Store Count Change in

Commitments Additional Contracted

1 Australia 23 18 2.5 2.5 2.5 2.5 2.5 2.5 -5 0 0


2013 15

2012 15

2 Dom. Rep. 1 3 5.5 5.5 2 -2 0


2013 11

2012 13

3 India 0 1 22.8 22.8 22.8 22.8 22.8 1 114 114


2013 114

2012 0

4 Japan 34 42 18.5 18.5 18.5 18.5 8 -11 0


2013 74

2012 85

5 Malaysia 6 8 12 2 -2 0


2013 12

2012 14

6 Mexico 71 91 6 6 6 6 6 6 20 -22 0


2013 36

2012 58

7 Philippines 26 41 15 -14 1


2013 0

2012 14

8 Puerto Rico 5 5 2 0 2 2

Agreement Amount

By Fiscal Expiration Year

2013 2

2012 0

9 Russia 0 0 7 7 7 7 7 0 35 35

Agreement Amount


2013 35

2012 0

10 Singapore 0 0 3.75 3.75 3.75 3.75 0 15 15

Agreement Amount


2013 15

2012 0

11 Thailand 4 8 6.5 6.5 4 -3 1

Agreement Amount


2013 13

2012 16

12 UK 48 55 5.2 5.2 5.2 5.2 5.2 7 8 0


2013 26

2012 34

Total 168

Sources: Company Data, Team Analyses


24

Actual Stores Future Store Commitments

Fiscal Year 2012 2013 2014 2015 2016 2017 2018 2019

Australia 23 18 2.5 2.5 2.5 2.5 2.5 2.5

China 2 2

Dom. Rep. 1 3 5.5 5.5

India 1 22.8 22.8 22.8 22.8 22.8

Japan 34 42 18.5 18.5 18.5 18.5

Malaysia 6 8 12

Mexico 71 91 6 6 6 6 6 6

Philippines 26 41

Puerto Rico 5 5 2

Russia 7 7 7 7 7

Singapore 3.75 3.75 3.75 3.75

Thailand 4 8 6.5 6.5

UK 48 55 5.2 5.2 5.2 5.2 5.2

Other 240 248

Forecasted Additional

Store Commitments

(+168 per year)

33.6 33.6 33.6 33.6 33.6

33.6 33.6 33.6 33.6 33.6

33.6 33.6 33.6 33.6

33.6 33.6 33.6

33.6 33.6

33.6

Store Closings 0.0 -6.3 -6.8 -7.4 -7.9 -8.6

Net Store Count 460 522 575 643 737 863 1017 1155

Table 4: Domestic Franchise Forecasted Store Growth Additional store commitments are dis-tributed forward over 5 years, with the assumption that an equal amount would be built each year.

Table 5: International Franchise Forecasted Store Growth

Actual Stores Future Store Commitments

Fiscal Year 2012 2013 2014 2015 2016 2017 2018 2019

Arizona 1 3 1 1

California 17 20 3.67 3.67 3.67

Colorado 2 2 2.6 2.6 2.6 2.6 2.6

New Mexico 2 3 1 1

North Carolina 8 8 1 1 1

Pennsylvania 8 8 3.4 3.4 3.4 3.4 3.4

South Carolina 9 9 2

Texas 9 9 1.3 1.3 1.3

Other 86 80

Forecasted Additional

Store Commitments (+26 per year)

5.2 5.2 5.2 5.2 5.2

5.2 5.2 5.2 5.2 5.2

5.2 5.2 5.2 5.2

5.2 5.2 5.2

5.2 5.2

5.2

Store Closings 0.0 -6.3 -6.8 -7.4 -7.9 -8.6

Net Store Count 142.0 142.0 156.9 175.0 195.8 215.2 239.3 256.7 Sources: Company Data, Team Analyses



25

Table 6: Forecasted Total Number of Stores Per Business Segment by Fiscal Year

Phase 2 : Forecasting Revenues

We forecasted revenues by multiplying the number of projected stores by the forecasted average weekly sales (annualized) per store type for each fiscal year. This method was used to project revenues for the Company, Do-mestic Franchise, and International Franchise segments. Table 7: Average Weekly Sales per Store Type

Fiscal Year 2014E 2015E 2016E 2017E 2018E 2019E

Company

Factory stores

Commissaries 203.3 215 228 242 254 267

Dual-channel stores

On-premises 37.6 39.9 42.2 44.8 47.0 49.4

Wholesale 50 53.0 56.2 59.6 62.5 65.7

Total 87.6 92.9 98.4 104.3 109.5 115.0

On-premises only stores 37.3 39.5 41.9 44.4 46.6 49.0

New small factory stores 31.8 33.7 35.7 37.5 38.6 39.8

Satellite stores 21.5 22.8 24.2 25.6 26.9 28.2

`

Domestic Franchise

Factory stores 52 55.1 58.4 61.9 65.0 68.3


International Franchise

Factory stores 39.8 37.8 37.8 38.8 40.7 43.1




26

Royalty & Fee Structure

Domestic

Associates 30% Estimated %

On Premise Sales 3% 75%

Wholesale 1% 25%

Brand Fund Contribution 1%

Area Developers 70% Estimated %

On Premise Sales 4.5% 75%

Wholesale 1.5% 25%

Brand Fund Contribution 1%

One-Time Development Fee $25,000 - $50,000

International

All Sales 6%

Brand Fund Contribution 0.25%

One-Time Development Fee $20,000 - $50,000

Table 5 : Royalty Fee Structure We calculated royalties to the company from the revenue forecast using the current Royalty & Fee schedule.

Notes: All domestic franchises sell products to on-premises customers, and most, but not all, also sell products to wholesale cus-

tomers.

Sales to wholesale customers generally constitute a smaller % of a domestic franchisee’s total sales than do the Company’s sales to wholesale customers.

Sales to wholesale customers comprised approximately 25% of domestic franchisee’s total sales in fiscal 2013.


27


28

Appendix 12: Porters Five Forces Model

Bargaining Power

of Suppliers

Competition in the

Industry

Threat of New

Entrants

Threat of Substitute Products

Final Rating: 3.4

Bargaining Power 5

4 3 2 1 0 **This model identifies and analyzes 5 competitive forces that shape every industry, and helps determine an industry’s strengths and weaknesses.

Threat of New Entrants - Average 1. Large capital requirements required to build a chain of stores/brand name 2. Favorable locations are already occupied 3. Economies of scale in distribution and raw ingredients 4. Product and brand differentiation Competition in the Industry - High 1. High Concentration of rivals and local chains. (Dunkin Donuts, Starbucks, McDonalds, etc) 2. Static Market Growth 3. High Fixed Costs 4. Perishable Products Threat of Substitute Products – Very High 1. Large choice of alternatives with similar products (Other kinds of desserts, pastries, or drinks) 2. No switching costs Bargaining Power of Suppliers - Low 1. Vertically integrated business with only commoditized raw ingredients 2. Large number of suppliers to choose from and low switching cost Bargaining Power of Customers - Average 1. Numerous kinds of buyers in the industry 2. Products are “craveable” in any economic circumstance

Scale of Interaction:

0 No Interaction

1 Insignificant

2 Low

3 Average

4 High

5 Very High

Sources: www.harbott.com, Team Analyses


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ROE

9.94% 66.74% 8.43%

10.58% 10.86% 11.59%

11.82% 11.36% 11.16%

ROA

4.47% 49.64% 6.05%

8.18% 8.50% 9.07%

9.27% 8.92% 8.81%

Net Profit Margin

2.10% 41.24% 4.77%

5.88% 6.30% 6.68%

6.80% 6.54% 6.54%

Equity Multiplier

2.22% 1.34% 1.39%

1.29% 1.28% 1.28%

1.28% 1.27% 1.26%

Total Asset Turnover

5.09% 5.34% 5.59%

5.78% 5.91% 6.04%

6.18% 6.30% 6.38%

Legend

2011 2012 2013

2014E 2015E 2016E

2017E 2018E 2019E

X

X

Net Income

7.6 166.27 20.78

28.42 33.24 38.55

43 45.06 48.87

EBIT

19.22 26.36 38.04

46.92 51.74 57.05

63 69.06 75.36

EBT/EBIT

46% 115% 95%

1 1 1

1 1 1

Net Income/EBT

85.8% 547.7% 57.2%

60.6% 64.2% 67.6%

68.3% 65.2% 64.8%

= X X



30

National Restaurant Association Restaurant Performance Index vs Krispy Kreme Doughnuts, Inc.

The National Restaurant Association’s Restaurant Performance Index (RPI) is a monthly index tracking the per-formance of the restaurant industry and is calculated based on answers given in response to a survey sent out to restaurateurs nationwide each month. The survey gauges answers in key areas such as same-store sales, traffic, labor, CAPEX, and others. Using a regression analysis between NRARPI versus KKD proved that the relationship between NRAPI and KKD are very significant.

Correlation Adjusted R2 t-stat p-value

KKD vs NRARPI .593 .346 7.964 .0000000012

Sources: Bloomberg, Team Analyses


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Disclosures: Ownership and material conflicts of interest: The author(s), or a member of their household, of this report does not hold a financial interest in the securities of this company. The author(s), or a member of their household, of this report does not know of the existence of any conflicts of interest that might bias the content or publication of this report. Receipt of compensation: Compensation of the author(s) of this report is not based on investment banking revenue. Position as a officer or director: The author(s), or a member of their household, does not serve as an officer, director or advisory board member of the subject company. Market making: The author(s) does not act as a market maker in the subject company’s securities. Disclaimer: The information set forth herein has been obtained or derived from sources generally available to the public and believed by the author(s) to be reliable, but the author(s) does not make any representation or warranty, express or implied, as to its accuracy or completeness. The information is not intended to be used as the basis of any investment decisions by any person or entity. This information does not constitute investment advice, nor is it an offer or a solicitation of an offer to buy or sell any security. This report should not be considered to be a recommendation by any individual affiliated with CFA societies Florida, CFA Institute or the CFA Institute Research Challenge with regard to this company’s stock.

CFA Institute Research Challenge

Documents

CFA Research Challenge - KKD Analysis